Classification And Functions Of Finance

This article will explain the classification and functions of finance.

The study of finance is as wide as human life itself. Only for the blinker wear, tunnel-versioned technical drudge has financed a narrow, mind-shrinking specialty. The understanding and practice of any branch of finance indeed require a wide range of general knowledge. The financial system is so widespread in its relations, so linked with all phases of human society, that very little happens which does not affect money or people’s use of it.

The state of the financial system reflects not only what businessmen and bankers are doing but also the whole range of a society’s values, ethics ideals, goals, politics, customs, and morals.

Thus the financial system is a web spreading through the entire realm of human affairs, reacting to every rustle and tremor that affects people’s attitudes or behavior. He whose finger is sensitive to financial events and trends has society and times.

Classification Of Finance

Finance can be classified as private or public finance. In every economy, the financial resources, or capital that moves the economy comes from the private or public sector.

Private sector finance is financial resources or capital input into the economy by individuals, groups, businesses, or associations. In developed countries, this type of capital constitutes about 90% of the total capital resources of that nation’s economy. This is because such economies are driven by the private sector. Government capital input constitutes only about 10%.

Public finance or public sector finance refers to government or state finances. It involves the raising of money through taxation and borrowing to spend money on public goods and services such as health, education, the environment, defense, social welfare programs, public utilities, etc.

Public finance is either in the hands of the Federal Government or local authorities. Increasingly, however, it is the federal or central government that exercises greater control of the public purse and which has taken over much of the spending powers of local authorities to avoid overspending or abuse of public funds.

In Nigeria, the capital resources of our economy come mainly from public sector funding. About 90% of the economic funding comes from the central government with the private sector contributing only about 10%. Our economy is therefore government-driven and this accounts for the slow pace of growth.

The fundamental difference between public and private finance is that private finance, whether of firms or individuals, starts with a given income as the framework within which expenditure must be planned.

Public finance is a modern state which starts with a given expenditure plan and the authorities adjust their income (revenue) using taxes and other sources, to match the expenditure.

Other classifications of finance do exist such as direct or indirect finance, corporate finance, managerial finance, international finance, investment finance, business finance, etc.

Classification And Functions Of Finance

Functions Of Finance

The functions of finance can be better understood when one considers the role of those who occupy the finance or financial managers’ seat in an organization or establishment.

However, the functions of finance are as follows:

1. Financing function

2. Investing function

3. Dividend or distribution function

4. Liquidity function


These four functions of finance can be regarded as managerial and as finance managers must plan, control, direct, and allocate resources including the capital of the firm for profit and maximizing the value of the shareholder’s equity.


1. The Financing Function

The financing function starts with financial anticipation of funds which is a crucial aspect as it is the starting point of the financial manager’s long-term responsibility of making sure that the firm achieves its set objective which is the maximization of shareholders’ wealth. Financial participation is provided by a forecast and market research. It is based on the result of this forecast and research that funds will be acquired.

In the acquisition of funds, the firm must consider the nature of its capital structure as this will have a far-reaching effect on its cost of capital mix decision. However irrespective of the composition of the firm’s capital structure, the eventual cost of capital of the firm will be influenced by timing, selection, and combination.

2. The Investment Function

The investing function is concerned with fund utilization in projects that will maximize the value of the shareholder’s equity. The financial manager must make sure that projects accepted by management yield a return that is equal to or greater than the firm’s weighted average cost of capital. When surplus funds exist all projects with positive net present value will be accepted but in periods of capital or fund rationing projects will be ranked in order of need and variability, profitability/risk.

In addition, the financial manager while performing the investing function must make provision for the short-term, medium-term as well as long-term needs of the firm.

3. The Dividend/Distribution Function

One of the functions of finance is to maximize the shareholder’s equity. To be able to do this, management must make sufficient returns or profits. The financial manager can retain the profit for reinvesting into the firm or payout some as dividends to the shareholders or transfer all to a reserve account. The dividend/distribution function requires the financial manager to distribute all or part of the firm’s profit to the owners. In doing this, however, the financial manager must take into consideration the following:

1. The tax position of the shareholders as this may likely lead them to pay higher taxes.


2. The need for immediate income by the shareholders as compared to share value growth through investment.


3. The closeness of the maturity date of short-term obligations of the firm.


4. The cost of external finance to sustain the growth rate of the firm, as well as the investment opportunities before the firm.


4. The Liquidity Function

The financial manager is aware that for the firm to remain afloat she must perform the liquidity function. Liquidity is the nearness to cash if not cash. A firm needs to be liquid to meet short-term obligations as well as meet the cost of running the business daily.

It is the responsibility of the financial manager to make sure that suppliers, workers, and others owned by the firm are paid. And that the asset profitability potentials of the firm get adequate funds for continuity and growth. In doing this the financial manager is constantly in the dilemma of liquidity as opposed to or in complement profitability.



Irrespective of these four functions of finance, the financial managers no matter what else they are called performs more than three major role or functions like financial participation of fund, financial acquisition of fund, and finally, the financial allocation of fund.

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